‘Gimmicks’ masked Lehman’s debt woes

BLUE-chip accountant Ernst & Young faces the prospect of expensive lawsuits after it was accused of “professional malpractice” for failing to challenge “accounting gimmicks” that allowed Lehman Brothers to hide $50billion (£33billion) of debt.

The accounting ruse, called Repo 105, let the bank mask the perilous state of its finances by artificially reducing its debt and beefing up its cash position. Lehman’s bankruptcy in September 2008 was a key point in the financial system’s collapse.

A damning, 2,292-page report into Lehman’s demise found E&Y guilty of a “failure to question and ­challenge improper or inadequate ­disclosure” in the bank’s financial statements. The accountant “took ­virtually no action” in 2008 after being alerted to Repo 105 transactions by a whistleblower.

City law firm Linklaters also came under fire for legally allowing the bank to use the accounting standard in London after US lawyers refused to let it do so in America. As a result, Repo 105 deals were processed in Britain.

In a statement, E&Y said its last audit was for the year ending in November 2007 and that “after an exhaustive investigation” the examiner made no findings that assets or liabilities were improperly valued for that year.

Linklaters said it gave its opinions in relation to English law and the report did not criticise those opinions. The report, ordered by the US judge handling Lehman’s bankruptcy, warned there were grounds for action against the bank’s chief executive Dick Fuld and former chief financial officers Chris O’Meara, Erin Callan and Ian Lowitt for negligence or breach of fiduciary duty. Banks JP Morgan and Citigroup also face lawsuits.

The report’s author, chief examiner Anton Valukas, also found the bank failed to disclose the true extent of its liquid assets that can be readily turned into cash to help out in a crisis.

On September 10, 2008, about a week away from going bust, the bank claimed it had $41billion in its “liquidity pool”. Two days later, just $2billion could be easily converted to cash. Much had been pledged as collateral to other banks.

Hiding the true state of the balance sheet was not responsible for Lehman’s collapse but the bank might have gone down sooner had the true nature of its finances been apparent.